As you know, Oligopoly market is a market structure. However, it may also be a phase, an evolutionary stage, through which industry may pass during its evolution. There are several examples in the corporate world, of how various industries have gone through the phases of monopoly, oligopoly and perfect competition.
There are two extreme forms of market structure: monopoly and the perfect competition. At the extreme left, there is a monopoly, where a firm produces the whole output of the concerned industry. At extreme right, there is the market structure of perfect competition, where a firm produces just a very little or almost negligible percentage of the total industry product output.
What if there are only two firms in a whole industry or market?
The oligopoly market structure in which there are only two competing firms is known as Duopoly.
Think about the only two bakeries in a small town in a remote area. Now go for industrial giants and recall to your mind the Boeing and the European AirBus, the two leading aircraft manufacturing firms, have been capturing the most portion of their respective market’s share.
Let’s take an example of two mobile phone manufacturing firms, the firm A and the firm B, which have been enjoying oligopoly, being the only two local firms satisfying the total market demand of 6 hundred thousand mobile phones per month.
As a manager facing oligopoly market, you must be very sensitive about product’s pricing and output decision.
Such questions rise now:
How the price-output decision of one, may affect the price-output decision of the other competitor?
How a firm’s efficient scale of production may increase or decrease the possibility of new entrants in the industry?
D=Total market demand for mobile phones
ATC= Average total cost to manufacture each mobile phone;
(ATC= Total cost/total number of units produced)
Two firms under Oligopoly Market (See the diagram - X)
The lowest possible price is $15per unit, which is the minimum ATC or average total cost because by setting a price for each unit below ATC level, a firm cannot even cover its expenses. Suppose, if one firm’s efficient scale of manufacturing is 3 hundred thousand mobiles phones a month, then there is room for another firm of the same efficient scale. Now two firms can satisfy the total market demand of 6 hundred thousand units per month. Such market structure of oligopoly is called Duopoly.
Three firms under Oligopoly Market (See the diagram – Y)
Let’s take a scenario of three firms competing for each other in oligopoly. Suppose the efficient scale of one firm is 2 hundred thousand mobile phones per month, three firms can satisfy the market demand of total 6 hundred thousand units, at the lowest possible price of $15.
The prices of these three firms will be highly interdependent and, therefore, similar. If the firm A starts selling the mobile phones at a comparably lower price, it will get a higher market share because customers tend to purchase products at a lower price while perceiving no product differentiation.
Your business is a part of the industry, whether it’s a factory, producing cosmetic items or a consulting agency, providing legal consultation services to your clients.
So, how can you go for profit maximization if your firm is part of an industry under oligopoly?
There are various oligopoly models like Cournot oligopoly, Sweezy oligopoly, Stackelberg oligopoly, Bertrand oligopoly, etc. Each oligopoly model has a different set of characteristics because of specific behaviors of their firms in the industry. The oligopolistic market where your firm operates may fall under the definition of any one of these oligopoly models or at least close to it.
These models assist in understanding various possible kinds of behaviors, under an oligopolistic market or industry, enabling you to develop effective strategies and business decisions to achieve better profit maximization opportunities.
Let’s have a quick look at some of these models, to get a little glimpse of how decision regarding price and production volume oligopoly are different in each model.
Under the Cournot model of oligopoly, a firm selects production volume level same as its competitor. That’s why each firm cannot earn a considerable economic profit.
While in Bertrand model of oligopoly, a firm sets the price for its product identical to its competitors’. Such actions result setting a price equal to their marginal cost, thus earning zero economic profits.
Firm managers under Sweezy oligopoly model perceives that their competitors will adopt reduction in price but will not follow an increase in price. This behavior results in leading very stable prices.
In the case of Stackelberg oligopoly model, there is a follower and leader approach. The leader takes action first, knowing how follower will react, and the follower simply compromises and tolerate whatever the profits are. This results in profits for each competitor but leader enjoys much more profit than the follower.
In any oligopoly situations, you should keep trying to create more entry barriers for any potential entrants, if your firm or the whole industry does not possess those crucial required traits, soon new competitors will jump in to reap profits, and new firms may enter soon, and the profitability of the existing firms drop.
How can you make more barriers against any entry of new competitors or scare away already existing competitors?
Before knowing it, you should remember that barriers are either structural or artificial. The already existing barriers, for example, are usually:
You can create hurdles for your rivals through adopting the strategies of backward integration by getting control for your supplies through owning or having exclusive access to suppliers. The forward combination may give you edge over your competitors through getting control over your product or service distribution.
Increased switching costs may stick your customers with you only.
Loyalty programs may enhance customer loyalty to your products or services.
Registering patents and licenses for your innovations or any unique developments will save you from any copyright infringements from your competitors